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FASB STAFF GUIDANCE ON ACCOUNTING FOR LEASE MODIFICATIONS RELATED TO COVID-19

FASB STAFF GUIDANCE ON ACCOUNTING FOR LEASE MODIFICATIONS RELATED TO COVID-19

Overview

The business disruptions and economic effects caused by the COVID-19 pandemic are far-reaching.  In this Alert, we discuss the FASB’s recent guidance on accounting for lease modifications granted by lessors to ease the economic effects of the COVID-19 pandemic – an area of accounting that has received significant attention during this health crisis.  

This Technical Alert has nothing to do with changes being made to adopt the FASB’s new lease accounting requirements (ASC Topic 842).  However, the last paragraph of this Alert discusses the FASB’s recent vote to change lease accounting effective dates

As part of short-term cash-management strategy during COVID, businesses are restructuring lease contracts to defer lease payments to future periods in anticipation of a “steadier” state, to forgive lease payments (abatement) for a specified time period, or to provide a cash payment to the lessee.  The modification of lease contracts requires careful consideration of the guidance in the FASB’s Accounting Standards Codification (ASC) Topic 842, Leases, (or ASC 840, Leases, if your company hasn’t yet adopted the new lease accounting requirements) to determine whether a modification results in a new lease or the continuation of the existing lease.  This evaluation can be complex and pose a significant strain on your resources, especially if your company has a large lease portfolio. 

The FASB acknowledged this concern and the need for relief during the COVID-19 crisis.  In response, the FASB issued a Staff Q&A on lease modifications that applies to entities that provide or receive lease concessions.

Key Takeaways

Question 1:  How Should Lease Concessions Resulting from COVID-19 Be Accounted For?

Without the FASB Staff Q&A, accounting for a lease concession would depend on whether the concession was part of the enforceable rights and obligations of the original lease agreement.  If the modification represented an existing contractual or legal right in the lease agreement, the concession would be accounted for based on the original lease agreement.  But, if the lessor’s COVID-19 concession is provided separately from the legally enforceable rights held by the lessee, the concession would be accounted for in accordance with the lease-modification guidance in ASC 840 or ASC 842. 

Whether your company is a lessor or lessee, figuring out whether the concession is or isn’t part of your current lease agreement can be a costly and challenging exercise.  The FASB Staff Q&A allows you to skip this evaluation.  You won’t have to evaluate each lease in your portfolio.  The FASB Staff notes that the Board “did not contemplate concessions being so rapidly executed as a result of a major financial crisis…”

Depending on which election you make, your company may account for all COVID-19-related lease concessions either: 

  • As if they were contemplated as part of the enforceable rights and obligations of the existing lease contract; or
  • As if they were a lease modification.

There is one exception, however.  If the concessions result in a substantial increase in the rights of a lessor or the obligations of the lessee, the FASB Staff requires you to follow the guidance in ASC 840 (or ASC 842) as written.  For example, if concessions require you to make substantially increased total lease payments compared to total payments required under the original lease, you shouldn’t apply the election to that lease.

Question 2: Do I Need to Make the Same Election for All My Leases?

No.  You just need to apply the election consistently to leases with similar characteristics and circumstances.

Question 3:  What is the Accounting for Lease Payment Deferrals Resulting from COVID-19?

The FASB Staff Q&A allows two approaches to account for payment deferrals (that do not result in substantial changes to the total cash flows) and states, in part (our emphasis added):

Some concessions will provide a deferral of payments with no substantive changes to the consideration in the original contract.  A deferral affects the timing, but the amount of the consideration is substantially the same as that required by the original contract.  The staff expects that there will be multiple ways to account for those deferrals, none of which the staff believes are more preferable than the others.  Two of the methods are:

  1. Account for the concessions as if no changes to the lease contract were made. Under that accounting, a lessor would increase its lease receivable, and a lessee would increase its accounts payable as receivables/payments accrue. In its income statement, a lessor would continue to recognize income, and a lessee would continue to recognize expense during the deferral period.
  2. Account for the deferred payments as variable lease payments (generally accounted for as an adjustment to lease income/expense in the period it arises).

Question 4:  What Disclosures are Required for Lease Concessions Related to COVID-19?

Everything you read now highlights the importance of financial statement disclosures related to the COVID-19 pandemic.  COVID 19 lease concessions are no exception.  FASB Staff Q&A states:

Based on existing disclosure requirements in GAAP, an entity should provide disclosures about material concessions granted (lessors) or received (lessees) and the accounting effects to enable users to understand the nature and financial effect of the lease concessions related to the effects of the COVID-19 pandemic.

Proposed Deferral of the Effective Date of ASC 842 for Private Companies and Public Not-for-Profits (NFPs)

Acknowledging the effect that the COVID-19 pandemic is having on business and the need for companies to re-prioritize their efforts away from implementing the new leasing standard, on May 20, 2020 the FASB affirmed its decision to defer the effective date of ASC 842 for private companies and public NFPs.  Once effective, the accounting standards update (ASU) will defer the effective date:

  • For private companies, including private NFPs, to fiscal years beginning after December 15, 2021, and interim periods beginning after December 15, 2022.
  • For public NFPs, to fiscal years beginning after December 15, 2019, including interim periods therein, only if they have not already issued financial statements.

The FASB Board stated that the expected benefits would justify the expected costs of the effective date deferrals and directed the staff to draft a final ASU for vote by written ballot.

Additional COVID-19 Guidance

This Alert complements our previous COVID-19 guidance that discussed the accounting for debt modifications from the borrower’s perspective, which is addressed in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 470-50, Debt - Modifications and Extinguishments, and FASB ASC 470-60, Debt - Troubled Debt Restructurings with Creditors.

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